Sunday, July 14, 2013

John Lanchester: Making British Bankers do the Perp Walk

The term "perp walk" refers to the habit police agencies have of parading someone accused and arrested for a crime into a public area where the "perp" can be viewed and photographed by the media. The "perp" is often handcuffed (at least) and wearing prison attire. The justification for the practice involves the need to transfer the accused from one location to another and the tradition of freedom of the press. Whether necessary or not, it has become quite common in the United States. What is indisputable is that it is a humiliating procedure for the accused. Public humiliation was probably its initial intent.

John Lanchester has produced two excellent articles in the London Review of Books on the status of banks and banking in the UK. The first details the recent sequence of crimes and incompetencies for which the bankers are guilty. The second article addresses what might be done to correct the banking situation. Here the focus will be mainly on the first article.

Lanchester hides neither his anger nor his incredulity at the activities that have been revealed.

"....a story full of failure, scandal, greed and incompetence."

Given the size of the banking system and its importance to the economy, allowing this type of behavior to continue is unacceptable.

"....the UK bank assets are 492 per cent of GDP. In plain English, our banks are five times bigger than our entire economy....We know from the events of 2008 and subsequently that the financial sector, indeed the whole world economy, is in an inherently unstable condition. Put the size together with the instability, and we are facing a danger that is no less real for not being on the front page this exact second. This has to be fixed, and it has to be fixed soon, and nothing about fixing it is easy."

Lanchester was moved to make this comment:

" their current condition our banks are an existential threat to British democracy, a more serious one than terrorism, either external or internal."

He fears that the revelations of misbehavior have been so frequent that the public has lost the ability or will to focus on the details. The public’s capacity for outrage has perhaps been diminished at a time when public outrage is most needed.

"In the midst of this cacophony of largely justified accusations, the banks have had a strange kind of good fortune: the noise is now so loud that it’s become hard to hear specific complaints of wrongdoing."

Lanchester is particularly incensed over one criminal activity that was so outrageous, so egregious, that it should be considered "the biggest scandal in the history of British banking." More explanation will be provided later.

One cannot address the banking issues appropriately unless one fully comprehends the depths to which the profession has sunk. For that reason he provides the reader a discussion of a series of banking activities that are intended to arouse anger and publicly humiliate the responsible banking executives—a form of literary "perp walk."

Interestingly, Lanchester shoves aside the greatest banking debacle of all, the orgy of risk taking that brought world economies to their knees and initiated the Great Recession. Perhaps he thinks it is a too oft-told tale, or perhaps he finds risky behavior less vile than the blatantly illegal activities on which he chooses to focus.

Banks are often described as "too big to fail." This descriptor is usually followed by the label "too big to jail." There is another comment that is, unfortunately, less often heard: "too big to manage."

Economic disasters can be generated in many ways. Let us not ascribe to duplicity what can be explained by simple incompetence. Lanchester begins with incompetence and the tale of the bank HBOS.

"The company was formed in 2001 by the fusion of Halifax, the UK’s biggest mortgage lender, with the Bank of Scotland, thus, in the words of the parliamentary report which rolled over this particular rock in April this year, ‘turning the "big four" banking groups into the "big five"’."

The downfall of HBOS was attributed to nothing more complex than just making too many bad loans. What is disturbing about this case is that HBOS was warned by British bank regulators that it was "an accident waiting to happen." Neither the bank nor the regulators responded to this assessment, and HBOS went merrily on its way lending itself into impending bankruptcy.

"This was nothing to do with go-go derivatives and fancy mathematical engineering; it was nothing to do with overpaid investment bankers making bets they didn’t understand. HBOS was almost entirely a traditional retail bank. ‘Whatever may explain the problems of other banks, the downfall of HBOS was not the result of cultural contamination by investment banking. This was a traditional bank failure pure and simple. It was a case of a bank pursuing traditional banking activities and pursuing them badly.’ In other words, the single biggest factor in the collapse of HBOS was simple incompetence."

But it was incompetence on a grand scale, and someone would have to pay a price. HBOS would take down not only itself, but also Lloyds bank. The government encouraged Lloyds to take over HBOS and rescue it from bankruptcy.

"Unfortunately the extent of the losses was so great they ended up bringing Lloyds down too, and the new combined bank was bailed out by the taxpayer a month after the takeover. We, the taxpaying we, now own 40 per cent of the combined bank; 2008’s ‘big five’ are now only four, and two of them (Lloyds-HBOS and RBS) are partly owned by a reluctant us."

With the Libor scandal we transition from pure incompetence to criminality based on a license to steal issued by the banking community.

"Libor is the single most important number in international financial markets, used as a reference point throughout the global financial system. It is a range of interbank lending rates, set after consultation between the British Bankers’ Association and two hundred and fifty-odd participating banks. During the daily process, each bank is asked the rate at which it could borrow money from other banks, ‘unsecured’ i.e. backed only by its own creditworthiness rather than by specific collateral."

Note that the question being asked is what rate could you borrow at, not what rate have you borrowed at. There is a world of difference between the two questions; one invites a guess or an estimate, while the other demands a precise answer. And the quality of the answer is very important.

"It seems bizarre that something so central to the global markets – $360 trillion of deals are pinned to Libor – should have such a strong element of invention or guesswork. The potential for abuse is immediately apparent. As MacKenzie prophetically said, ‘the obvious risk to the integrity of the calculation is that a bank on a Libor panel might make a manipulative input, trying to move Libor up or down so as to influence interest rates or the value of its swaps portfolio.’ Surprise! After the crisis, when investigators were taking an energetic interest in Libor, it turned out that that was exactly what had been happening, not just at one or two banks but across an entire swath of the industry."

Is it any surprise that an invitation to cheat would be recognized as an opportunity to cheat and utilized as such? Lanchester is sufficiently cynical about the power of the banks in London to suggest that these actions might have gone unreported had not other countries and their less-friendly law enforcement agencies been brought in to investigate.

"From this perspective, the important fact about Libor is that while the rate is controlled by the British Bankers’ Association, it is widely used, indeed is omnipresent, within the US financial system. So manipulation of Libor is a crime not just in the finance-friendly City of London, but in the eyes of US law enforcement. That profoundly changes the mood music, and the resources devoted to investigating wrongdoing. If Libor had only been of relevance within the UK, the same actions could have taken place in the same institutions and my suspicion is that we wouldn’t have heard a word about it."

The fallout from the various criminal investigations is still accumulating.

"In June last year, Barclays paid £59.5 million in fines to the Financial Services Authority, $160 million to the US Department of Justice (DoJ), and $200 million to the US Commodity Futures Trading Commission (CFTC), making a nice round total of about £290 million. (It’s worth pausing for a moment to register the full magnitude of that: from one single bank, more than a quarter of a billion quid in fines....In December, the Swiss bank UBS agreed to pay $1.2 billion to the DoJ and the CFTC, £160 million to the FSA, and 59 million in Swiss francs to the regulators back in the old country. That’s a total £970 million...."

"There’s plenty more to come: Deutsche Bank, Citigroup, Credit Suisse and JPMorgan Chase, four of the biggest banks in the world, are under investigation, along with many of their peers, and the bodies pursuing them include not just the DoJ, CFTC and FSA but also a variety of US state-level attorney generals."

Note that these figures are for fines levied by government agencies for criminal behavior by banks. They do not address the fact that anyone who believes they lost money because of Libor-related manipulations can sue for restitution. The amounts involved could be enormous and the legal wrangling could go on indefinitely. Lanchester provides one illustrative example.

"To give just one instance where there are certain to be dozens and perhaps hundreds more, the city of Baltimore and a number of associated parties are suing a group of banks for a ‘global conspiracy to manipulate Libor’. The US municipalities’ losses on the relevant interest-rate swaps have been put at $6 billion, in addition to the $4 billion they’ve already had to pay to get out of them – that sounds like a lot, but they had bought $500 billion of swaps. Multiply this phenomenon globally and the full scale of the potential disaster for the banks becomes apparent."

Lanchester then shines a light on some activities that qualify as "pure" criminality. These are instances that involved breaking painfully clear laws in order to aid criminals or rogue nations.

The first instance involves the bank Standard Chartered which was accused of spending a decade facilitating deals with the Iranian government that are illegal under US law.

"The regulator said that the bank had been operating the scheme/scam for a decade and had used it to hide more than $250 billion in deals."

After the obligatory claims of innocence, the bank agreed to pay fines.

"In September the bank paid $340 million to the DFS in settlement, then in December another $227 million to the DoJ and $100 million to the US Federal Reserve, and accepted a ‘deferred prosecution arrangement’ in which the authorities said they wouldn’t prosecute the bank if it abided by the conditions made in the settlement agreements."

With the arrogance that only a guilty banker can summon up, the chairman of Standard Chartered continued to profess innocence of any criminal intent. The US DOJ was sufficiently angered to actually threaten to prosecute a criminal banker. The result was this statement issued by Standard Chartered:

"’....To be clear, Standard Chartered unequivocally acknowledges and accepts responsibility, on behalf of the bank and its employees, for past knowing and wilful criminal conduct in violating US economic sanctions, laws and regulations’."

Consider the enormity of the act, the confession of guilt, and the fact that nobody went to prison. "Too big to fail, too big to jail seems" to be the operative mandate.

Next up is the bank HSBC which managed to combine illegal transactions with countries like Iran with laundering money for drug cartels.

"L’affaire HSBC had more entertainment value in that it involved laundering money for drug dealers. The DoJ said that the bank had laundered at least $881 million in money for Mexican and Colombian cartels, and another $660 million in sanctions-avoiding transfers with Iran, Cuba, Sudan, Libya and Burma. Some of the details concerning the drug money were lurid. Drug dealers deposited hundreds of thousands of dollars in cash at HSBC in Mexico, and to facilitate matters, even designed special boxes to hold the cash that made an exact fit with the holes in the bank tellers’ windows."

"As part of the deferred prosecution deal, the bank agreed to have an independent monitor inside the bank, checking on its compliance, for the next five years – an unprecedented arrangement for a British bank. Also unprecedented was the size of the fine: $1.92 billion. That’s a stupendous amount of money for a fine, but it might not be enough to satisfy US critics of the deal, many of whom think that a criminal prosecution is preferable to the deferred prosecution arrangement; the judge in charge, John Gleeson, hasn’t yet signed off on the DPA. This story, already as bad as any crisis has ever been for HSBC, may yet turn even worse."

Finally Lanchester arrives at the greatest scandal of all, and the most troubling acts of criminality. It is one thing to cheat an impersonal country or business or another trader who might be willing to cheat you. It is quite another thing for a bank employee to look a bank depositor in the eye and lie to them in order to extract profit from them.

The issue at hand is a form of insurance known as PPI (payment protection insurance). As the name implies, it is insurance designed to cover payment for mortgages and bills when, for whatever reason, a customer becomes unable to make the payments. Obvious examples include people who lose their jobs or become too sick to work. The banks marketed what appeared to be an excellent form of insurance, but configured it in such a way that many people they sold the insurance to would never be able to collect on it.

"The problem was that the majority of people who bought the policies would not, in the real-life instances for which they were buying the policies, be able to use them. Two categories of people who were not eligible to make claims against PPI were the self-employed and anyone with a pre-existing medical condition. They couldn’t use the insurance, but they were, in their (our) hundreds of thousands, sold it anyway. They weren’t told the basic facts about the insurance they were buying, facts which were not merely marginally relevant or potentially relevant, but which directly contradicted the raison d’ĂȘtre of the policies. The banks sold them to customers in the knowledge that they were not and would never be of any use to them. In many cases, customers bought products which had PPI tacked on, without being told they were being charged a premium for insurance which for many of them was useless."

This practice is obviously outrageous, but the notion that the bankers thought they could get away with it is equally outrageous.

"That’s what’s costing the banks all that money now: refunding the money paid, plus interest which was added on top, plus 8 per cent interest which could have been made if the money wasted on PPI had been put to some legitimate use. The average pay-out by the banks is in the region of £2750. It’s all those payments which add up to the £16,000,000,000 that the banks are going to have to pay; which gives you some sense of just how many people were mis-sold these crappy policies."

The British are at least formally aroused. Commissions are issuing reports and threats of jail time for banking executives are being bandied about. It is difficult to see how anything less would make a difference. There is a long history of issuing fines for bad behavior. The result seems to be more frequent bad behavior. Banks have so much money at their disposal and so many options for utilizing it that fines become a mere cost of business that can be passed on to the banks’ customers.

Money is power and the banks have plenty of it. They usually are able to use their resources to escape from serious regulatory blowback, but even in cases when one profitable area of activity is shut down, there are other opportunities available to replace it.

Truly, the only public recourse is to start with the chief executive of a bank guilty of criminal activity and start throwing people in prison.

Let’s follow a literary perp walk with a real one! Bankers in shackles and orange jump suits! Live television coverage!

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